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Policy Research Report: Finance for Growth: Policy Choices in a Volatile World (2001)

The World Bank has long recognized that poverty reduction and growth depend on effective national financial systems. Understanding just how finance contributes to development—and how good policy can help guarantee its contribution—has been the focus of a major research effort at the Bank. This research has included systematic case study analyses of the experiences of specific countries, as well econometric analyses of extensive cross-country datasets.

Finance for Growth draws on this research and uses it to develop an integrated view of how financial sector policy can be used to foster growth and bring about poverty reduction. At its best, finance works quietly in the background; but when things go wrong, financial sector failures are painfully visible. Both success and failure have their origins largely in the policy environment. Policy needs to create and sustain the institutional infrastructure—in such areas as information, law, and regulation—that is essential to the smooth functioning of financial contracts. Above all, policymakers need to work with the market to help align private incentives with public interest. As the ever-diminishing cost of communications and information technology leads to greater integration of global financial markets, policymakers face new challenges in ensuring this alignment. Governments must be prepared to recast their policies to take advantage of the opportunities resulting from global integration, and also to guard against the associated risks.

The report presents several key messages, including:

A strong financial sector contributes to long-term prosperity.

Governments are not good at providing financial services – even when a crisis hits.

Well-functioning financial markets need the legal and regulatory underpinning that effective governments provide, and a regulatory and supervision strategy based on harnessing incentives.

Finance for Growth was written by Gerard Caprio (Development Research Group and Financial Sector Strategy and Policy Department) and Patrick Honohan (Development Research Group), with the editorial assistance of Mark Feige. It takes stock of and synthesizes results from a research program on financial sector issues overseen by Paul Collier and Lyn Squire. Original research as background for this report includes work by the authors and by Thorsten Beck, Craig Burnside, Robert Cull, Asli Demirguc-Kunt, David Dollar, James Hanson, Philip Keefer, Leora Klapper, Aart Kraay, Ross Levine (now at the University of Minnesota), Millard Long, Giovanni Majnoni, Maria Soledad Martinez-Peria, and Sergio Schmukler.